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Markets: A journey to the past!

Mar 28, 2006

Are the Indian stock markets over valued? Is there any upside left? Can the phenomenal rise in the stock market over the last three years sustain? With the indices making new highs every other day, these are the questions that often cloud the minds of the investor. In this article, we shall give a historical perspective of the Indian stock market and what lies ahead?. For the purpose of the article, we have collated data for around 2,500 companies (see graphs below). If history is of relevance, the charts do indicate that we have come a long way with the market capitalisation moving into new highs. The combined market capitalisation of the 2,500 companies has grown at a CAGR of 74% in the last three years. In the same period, the CAGR in sales and net profits of these 2,500 companies was 17% and 36% respectively.

There are many reasons for the sharp rise in market capitalisation in the last three years.

  1. The corporate sector has been through a very extensive restructuring phase, which includes shedding excess employees and pruning overheads. Part of the cash flow generated from this restructuring exercise was utilised towards retiring high cost debts. The fact that interest rates declined sharply in the last ten years also helped matters.

  2. The restructuring was accompanied by economic recovery towards the early 2000, which had a positive impact on the asset utilisation factor. Consequently, with costs under control, the benefits of incremental sales accrued at the bottomline level. This is clearly reflected from the reduced gap between operating margins and net margins in the last ten years (see adjacent chart).

Going forward, while competition is expected to intensify further, interest rates seem to have bottomed out. And this is the phenomenon across the globe. All the developed nations have witnessed a sharp rise in interest rates in the last two years (though on a lower base). Though demand prospects are promising, in our view, India Inc. has entered the capital expenditure phase (like in the mid 1990s). While this is a positive in the long-term, we believe that profitability is likely to remain under pressure in the medium-term i.e. the capacity expansion is likely start contributing to growth only after two years. Meanwhile, corporates will have to bear higher depreciation and interest charges.

To conclude...
While we continue to remain positive on the 'India Story' in the long run, we do not subscribe to the view that the momentum in the Indian stock market will sustain for ever (there are pockets of insanity in valuations). At the current juncture, Indian stocks are no more 'value buys'. As Warren Buffet once said, 'Price is what you pay and value is what you get'. To that extent, we must exercise caution in our stock selection.

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